The Energy Space

*On December 27th, EOXLive published a 2013 outlook for crude oil and natural gas. If you have not received it or would like a copy, please email tpawlicki@eoxlive.com.

Energy Price Outlook

The short-term trend of the energy markets has been on the upside for nearly a month now, but prices are approaching levels that have traditionally caused problems for rallies. The weekly chart below suggests that WTI may be able reach the falling trendline near $101/bbl without creating any appearance of excess, however, demand would then become a concern as rationing will eventually return. Additional pressure will come from Friday's inventory report which showed that demand finished the year fairly weak and that product inventories grew once again late in Dec. But the market may remain short-term focused, with positive factors on the radar including improved Chinese PMI data, the S&P 500's close at a new 5-year high on Friday, modest improvement in payrolls, the grounding of Shell's oil rig in Alaska, and the ramp-up of the expanded Seaway pipeline this week. Environmental groups have already called on the president to suspend drilling permits in the Arctic. The pipeline expansion should help WTI against Brent crude, and we entered a spread recommendation in June futures at -$14.25 on Friday morning, with a target at -$8.00.

Friday's trade in WTI settled 17c/bbl higher while Brent finished 83c/bbl lower. The differential was affected by news late Wednesday regarding the ramp-up of shipping capacities on the Seaway pipeline between Cushing Oklahoma and Freeport Texas. This week, the pipeline will begin transporting 400 kb/d of WTI crude to the Gulf Coast rather than the 150 kb/d that was the case previously. The market also gained support from the non-farm payroll number which rose 155K vs. 150K expected, and more importantly, broke the string of ADP over-estimation that was the case in the January reports in the last two years. The ISM non-manufacturing report didn't offer much impact on Friday, but its 1.4 point increase to 56.1 could be beneficial to oil. The chart on the next page shows that the two series have had a decent correlation since 2009 as oil prices have been focused more on economics than pre-2009 issues such as strong Chinese demand and weak supply growth.

General support may continue to be seen from economic improvement in China and Europe as well. Recall that the HSBC manufacturing PMI numbers reported on Dec 31st suggested that the economy has continued to improve. The Shanghai Composite has attracted more attention due to its strong performance in Dec, and could be a favorable indication of future oil demand from the country. We analyzed this recently to show that Chinese oil demand has tracked manufacturing activity in recent years. Europe has been improving too, and after Friday's release of the composite PMI, Markit's economist said that the worst of the economic downturn may be behind the region.

The negative side will focus on the prospect that the $8/bbl rally in the last month will begin to ration demand for oil products in the months to come. Gasoline prices have gained 20c/gal in the time, and is about six weeks away from the ramp-up that takes place in anticipation of the summer driving season. Another worry for oil prices could come if economic data is bringing forward activity from the spring and summer months. Construction jobs gained 30K on Friday likely due to work being done at a time of year when seasonal adjustment factors don't anticipate it being done. That was the case last year, as warm winter weather helped employment and other economic data in the U.S. show solid improvement in Q1 only to see weakness set in during Q2.

Natural Gas

February futures settled 8.9 cents higher on Friday as attention turned toward chances for below-normal temperatures in the western U.S. later this month. That forecast was made by Earthsat and has been evident in the 8-14 day NOAA outlooks for the last few days. Some support was also given to the market by the inventory report, which showed a draw of 135 bcf vs. 130 bcf expected in the consensus. An interview with T Boone Pickens on Bloomberg Radio may have been slightly positive just for the reminder that natural gas truck engines are continuing to be developed. He said that there will be a new 12 liter natural gas fueled heavy-duty engine available from Cummins in 2-3 months. It can be difficult to gauge the natural gas transportation movement, as there hasn't been much news on the topic recently and Westport Innovations has traded fairly flat for the last three months or so.

Prices broke down sharply last week on Wednesday and rallied somewhat on Friday. Friday's trade moved up to resistance from the Dec 14th low at $3.316 and peaked at $3.299. Open interest gained 9,000 contracts that day which implies that traders are still angling for further downside activity. We would maintain a sell-the-rallies approach until there's any significant and lingering cold weather in the forecast.

Global Economic & Dollar News

» The Eurozone Composite PMI was revised down 0.1 to 47.2 in the final December reading. More importantly, the Markit economist suggested that the worst of the economic downturn may be behind the region.

» Non-Farm Payrolls were +155K vs. +150K expected. There were +14K in revisions. Gains were seen in construction (+30K), manufacturing (+25K), education (+65K), and hospitality (+31K), while government employment fell 13K. The unemployment rate was unchanged at 7.8%, with Nov revised up 0.1% from 7.7% originally. The U6 rate of underemployment was unchanged at 14.4% as was the labor force participation rate of 63.6%.

The EIA reported oil inventories which were considerably more bullish than the consensus expectations, but were generally in-line with that reported by the API on Thursday afternoon. Oil stocks fell much more than expected while gasoline and distillates gained more than consensus. The market didn't show much of a reaction overnight Thursday on the API or on Friday morning after the EIA figures. In all likelihood, the oil numbers were affected by year-end issues and tendencies of inventory holders to liquidate in the last weeks of the year. That trend typically reverses at the start of the new year and builds for around five months. Gasoline continues building through Feb as demand remains weak, but distillates usually fall through Apr as heating demand remains strong. Overall, it's difficult to read much into these numbers as most will reverse direction in the next week or two. The data and our analysis follow below.

*The API convergence figures are the amounts that EIA data need to change in order to match the previous day's API figures

Oil stocks were -11.1 MB vs. -0.5 MB expected. In our view, the consensus (including us) was off the mark because inventory holders had given no sign in Dec that they would liquidate inventories into year-end as is normally the case. The three weeks prior to yesterday's numbers had dropped only 707,000 bbls whereas the five-year average drops 9,782,000 over the same three-week period. The consensus expected that trend to continue since there was no evidence that it wouldn't. Imports were a culprit in the decline and fell 931 kb/d on the week. Inventories finished the year at 39.82 MB above the five-year average, which is below the 50.11 MB difference the week before and better than the 50.92 MB record set Apr 24th 2009. Total oil demand increased 37 kb/d while refinery inputs gained 22 kb/d. Oil production was +1 kb/d. Overall, it's difficult to believe that these numbers really mean much for the market going forward.

Gasoline inventories were +2.6 MB vs. +2.0 MB expected. Inventories are 10.88 MB above the five-year average vs. 10.77 MB above it the week prior. Interestingly, inventories gained as much as they did despite a 628 kb/d drop-off in refinery production, or 4.4 MB over the course of the week. There can be delays sometimes with the production data reaching inventories. The previous week's production was +657 kb/d, or 4.6MB over seven days. Imports also took away from inventories as they fell 115 kb/d. Demand was additive as it weakened 90 kb/d and finished the year at 502 kb/d below the five-year average. Overall, the numbers were slightly bearish for gasoline prices as inventories remain comfortably above the five-year average, but they may also have limited impact due to the year-end.

Distillate stocks were +4.6 MB vs. +1.0 MB expected. The increase was more surprising than in gasoline because they have been running much tighter than in gasoline and refinery output hasn't seen as much volatility as it has in gasoline. Refinery production dropped 42 kb/d on the week after gaining 26 kb/d the previous week. Demand fell sharply again, this time by 455 kb/d and followed a 503 kb/d decline last week. Distillate stocks are now 21.62 MB below the five-year average compared to 25.12 MB below it last week. The distillate number is negative overall and helps explain the underperformance compared to gasoline in the last two months. Warm winter weather also is to blame.

Natural Gas Commentary

Published Friday afternoon, 1/4/13

Natural Gas traded higher, settling $3.287 up $0.089 2.7%. The curve was firmer, 13/16 $0.03 tighter (J13/F14 $0.02 better). Hub cash was ~$0.03 back this morning, Z-6 fell to $1.00 to $4.80. The 12z was warmer than overnight models across the Central and Southeastern U.S. The Western U.S. was slightly cooler during the 6-10 day. The 11-15 day was significantly warmer East Coast and upper Midwest. The EIA reported a withdrawal of -135 Bcf, bullish vs market expectations ~-130. The withdrawal was bullish vs last year's 76 Bcf withdrawal and the 5-yr average 113 Bcf withdrawal. The YoY and 5-yr surplus tighten to 45 and 361 Bcf. Next week we expect ~195 Bcf withdrawal, bullish vs 2012's 95 Bcf withdrawal and the 5-yr average 122 Bcf withdrawal. Baker Hughes reported NG rigs rose 8 to 439 (GOM unch, ND -1, PA +3, TX +4).